5 Things That Cause Small Business Owners to be Audited

The Internal Revenue Service is in business to make as much money as it can, as efficiently as it can. Congress wants the IRS to increase revenue by looking for sure audit targets. The following five items increase your chances of being found and being audited. These five errors can be very costly to small business owners.

1. 1099/Document Matching: The IRS records 1099s issued in your ID number. If your business is not reporting revenue for at least the amount of 1099s attributable to your ID number, you will receive a letter notifying you of an IRS examination.

2. Employees v. Subcontractors: If your business is reporting compensation for services mostly as subcontracting services instead of as an employee’s wages, you are looking for trouble. One of the top priorities in 2011 for the IRS is to look at how services by individuals are categorized. Small businesses pay less tax when they consider services from a subcontractor instead of from an employee. Too much subcontracting deductions v. W2 payroll can get you audited. In addition, not issuing 1099s at all if you are reporting commissions or subcontracting services can also get you that audit letter.

3. Auto/Truck Expense: The IRS looks at your deductions and if too much is taken for auto or truck expenses, especially for service type businesses, you are increasing your chances of being audited. Small business owners can take auto expenses at the rate of 50 cents a mile  (2010) and wrongly assume that no documentation, (receipts), are required. This is one expense the IRS is focusing on. Too large of an auto expense taking the Standard mileage method increases your chance of being examined.

4. Losses/Low Net Income: The IRS is wary of small business owners who show a small profit or loss for several years in a row. The IRS has your address and they know what it costs to live in your neighborhood. If you own a fairly nice home with a mortgage and your tax return has shown a net income of say 1 to 35 thousand dollars or a loss for several years, you will probably get noticed or examined.

5. Earned Income Credit: The IRS is on the prowl for business owners who report income at a level that will allow them to receive the earned income credit, but not pay any tax. At certain income levels of around($5,000 to $35,000), income from a business and certain other factors, such as dependent children under age 19 or full time students under 24 years of age, can create a refund via the earned income credit up to $5,000 or more. The IRS is aware of this and they will audit you if they believe you are manipulating your income to receive the EIC and a big refund.

Running a small business can require lots of hard work and risk. The last thing a business owner needs is an audit. Dale S. Goldberg & Associates, CPA, is an expert in the field and would be happy to meet with you to reduce your risk of being audited. Call us today at 215-342-4200.

Using the IRS as a guide, a tax audit is defined as

a review/examination of an organization’s or individual’s accounts and financial information to ensure information is being reported correctly, according to the tax laws, to verify the amount of tax reported is accurate. [source]

Contrary to popular belief, many taxpayers think that being audited is an indication that there was some sort of user-error made when filing their taxes. However, being audited does not necessary indicate that this is the case. In fact, you can be audited for any of the following reasons:

• Random selection and computer screening – sometimes returns are selected based solely on a statistical formula.
• Document matching – when payor records, such as Forms W-2 or Form 1099, don’t match the information reported.
• Related examinations – returns may be selected for audit when they involve issues or transactions with other taxpayers, such as business partners or investors, whose returns were selected for audit.

Those who are audited are notified in one of two ways: by phone or by mail. The IRS representative will let you know what documents are needed from you in order to complete the audit. As per the law, small business owners, individual taxpayers and other corporations are required to retain records used for the purposes of prepare tax returns. As a general rule, you should aim to hold onto tax records for a minimum of 3 years from the date that the tax return was initially filed. An accountant or reputable tax service can also provide and offer assistance in tax audit matters.

If you have questions about tax audits or the process of being audited, make sure you ask your CPA or check out the IRS website for their informative video series titled Your Guide to an IRS Audit.

[source: IRS Website]

When hiring a certified public accountant (CPA), it is important to make sure that you are hiring someone whom you trust. The most common mistake that people make when they are hiring CPAs is they assume that a CPA strictly works with numbers and mathematics only, when in fact there is much more to it than that. For instance, CPAs often act as trusted business finance advisors, looking at client portfolios and assessing various aspects of business growth and development such as: small business accounting systems, corporate tax planning and payroll taxes. When you are a business owner, you should consider your CPA to be part of your management team.

3 Tips When Hiring a CPA

1. Research. Before you hire a CPA, ask around to friends, family and colleagues who may have used a CPA in the past and can recommend someone. Beyond this, you can always check the Yellow Pages as well as the Internet. On the Internet, look for CPAs whose websites provide a plethora of information and appear to be well-put-together. Testimonials, accessible contact information and/or forms and actual names of people who work at a CPA firm are all positive signs.
2. Have questions. Before you decide on any one CPA, be prepared to narrow down your choices to a few CPAs to which you can ask a few questions regarding both their qualifications as well as their services. Questions to ask may include things like: whether or not they’ve passed a national CPA exam; whether they are licensed to practice in that particular state; professional organizations that he or she belongs to; areas that the CPA specializes in, etc.
3. Be comfortable. The CPA that you hire should be someone that you feel comfortable sharing private financial information with. He or she should be able to demonstrate personalized attention to detail for the specific financial needs and goals that you have in mind. Using their background, they should be able to provide you with a clear visual plan for your finances as well as take the time to explain things that you may not fully understand.

It may take a little ‘leg work’ at first, but finding the right certified public accountant to suit your various financial needs will be worth it in the long run!